Sunday, February 03, 2008

The Economy 101

During the final two decades of the twentieth century, the U.S. economy was the envy of the world. The dollar was the world’s dominant currency. Foreign central banks accumulated dollars as their main reserve asset. Commodities like oil were denominated in dollars, and emerging countries like Argentina and China linked their currencies to the dollar in the hope of achieving U.S.-like stability.

But as the century ended, so did this extraordinary run. Tech stocks crashed, the TwinTowers fell, and Americans’ sense of omnipotence went the way of their nest eggs.

The dollar is falling in value versus other major currencies and plunging versus gold. The whole world is watching, scratching its collective head, and wondering what has changed. The answer is that everything has changed, and nothing has. The spectacular growth of the past two decades, it now turns out, was a mirage generated by the smoke and mirrors of rising debt and the willingness of the rest of the world to accept a flood of new dollars. Like a family that has maintained its lifestyle by maxing out a series of credit cards, America is at the point where new debt goes to pay off the old rather than to create new wealth.

A quick scan of world history reveals them to be depressingly familiar. All great societies pass this way eventually, running up unsustainable debts and printing (or minting) currency in an increasingly desperate attempt to maintain the illusion of prosperity. And all, eventually, find themselves between the proverbial devil and deep blue sea: Either collapse under the weight of their accumulated debt, or keep running the printing presses until their currencies become worthless and their economies fall into chaos.